The Best Way To Get Out Of Debt

The Best Way To Get Out Of Debt

The Best Way To Get Out Of Debt

I am in debt. A lot of debts. I have more than $700,000+ in outstanding non-mortgage debts. However, I am not any poorer because of this mountain of debts. It’s actually helping me make more money instead of being a burden that weighs down on my finances and eating away my income every month. I am not stressed by debts nor am I working just to pay it off.

You see, a few years ago, I discovered that not all debts are bad. There are good debts too. These are debts that you inherited for the purpose of investing in appreciating assets like stocks and real estates. It takes a great deal of discipline and self-control to borrow to invest. If done correctly, you will have debts working for you instead of you working to service your debts.

You must be wondering, “what does using good debts have to do with getting out of debt?” Two simple words: discipline and self-control. To get out of debt, you can use the same discipline to rein in your spending. You’ll also need to have the self-control to ensure that you purchase more of what you need rather than what you want. Once you have developed the discipline and self-control, you can choose the best way to get out of debt. Let’s take a look at the different methods.

The Debt Avalanche Method

The debt avalanche method is one of the two popular ways to get out of debt that most personal finance experts will recommend. This method involves paying the minimum payments for all of your outstanding debts and use any extra money to pay off your highest interest debt. For example, if you have three credit cards with interest rates of 12%, 15%, and 20%, you’ll pay the minimum payment for the first two credit cards. You use the rest of your money to pay off the 20% credit card.

From a pure logic point of view, this method is relatively efficient as you tackle the most costly debt first. From a savings point of view, it’s not getting you out of debt any faster. There are better ways.

The Debt Snowball Method

The Debt Snowball method is the other popular way to get out of debt. This method involves paying the minimum payments for all of your outstanding debts and use any extra money to pay off your smallest debt load first and then the second smallest. For example, if you have four loans with outstanding amounts of $2,000, $3,000, $5,000 and 20,000, you’ll pay the minimum payment for the three largest loans. You use the rest of your money to pay off the smallest loan ($2,000 loan) first.

From a mathematical point of view, this method is relatively inefficient most of the time as you ignore the interest cost of the loans. From a psychological point of view, it can be a motivating factor as you are slashing down your debts. One by one. However, it’s not getting you out of debt any faster or save you more money. Once again, there are better ways.

The Debt Consolidation Method

The idea behind the debt consolidation method is to simplify your debts from a few into one. Ideally, the new consolidated debt will be the lowest cost and will save you more money over the term of the loan. For example, if you have three credit cards with interest rates of 12%, 15%, and 20%, you can try to consolidate your loans into one with a lower interest rate of 4%. Comparing to the debt Avalanche or Snowball, this method is much more efficient.

If you own a home, you can use the equity in your home by refinancing your mortgage to a higher amount at a lower interest rate than your outstanding loans. You use the proceed to pay off the outstanding loans. Alternatively, you can also apply for a home equity line of credit (HELOC) and do the same. However, be warned that this method is only a quick fix to your debt problem. It’s not a long-term solution.

The Balance Transfer Method

The balance transfer method involves applying for a new credit card that allows you to transfer your balance from other cards to the new card. For most cards, it’ll cost you about 1% of the balance that you transfer. You pay a low-interest rate of 0% to 1% for one year (the low-interest period). You don’t need to pay the minimum payment for that period. However, the interest rate skyrockets after the lower interest period are over.

When you choose this method, hopefully, you’ll continue to make your loan payments and take advantage of the low-interest rate. If you can’t pay off the whole loan before the low-interest period expires, you can repeat the process with another card. Be warned that this method has the potential to get out of hand if don’t continue to pay off your debt.

Debt Relieve Method

If you had tried all of the four above methods and you are still unable to make a dent on your debt balance, the last resort may be to contact a debt relief consultant. I had no experience with this method, but from what I had read, it’s an alternative to declaring bankruptcy. If you can’t make your payments and your balance keeps on ballooning, this is probably your last option. Hopefully, no one has to resort to this.

My Two Cents

With all these debt reduction methods to get you out of debt, there is absolutely no guarantee that you’ll be debt-free once you paid off your debt. The best way to get out of debt is not getting into debt in the first place. You’ll never have to find the best way to get out of debt if you had never gotten into it. Hence, live within your means and spend less than your earnings so you’ll never have to be in debt.

So, have you ever been in debt? If yes, which method was the best method that you used to get out of debt? Do you know of another debt elimination method that was not mentioned here?

Leo T. Ly, Canadian Personal Finance Blogger/Enthusiast and a Realtor Living in the Markam, Ontario, CanadaAbout Leo
I am a Canadian personal finance blogger/enthusiast and a Realtor living in Markham, Ontario, Canada. I built a net worth of a million dollars over a ten year period. I did it by being a disciplined saver, taking advantage of income tax rules and borrowing money to invest rather than for consumption. I am often excited to take advantage of free money from employers and governments in addition to building more passive income sources. After accumulating my first million dollars, I am now embarking on a second journey towards achieving financial independence. On this journey, I will strive to increase my net worth to two million dollars and retire by the age of 48 - Freedom 48. Come along and follow my journey on Facebook, Twitter, Pinterest or Google Plus.

There are 22 opinions expressed on this post.

  1. Well I am confused. I read all four methods and I still don’t get how you can be relaxed with that amount of debt. I’ve never been in debt a day in my life and I’d like to keep it that way.

    1. @Akamatra, the reason why I am so relaxed is that I am not borrowing for consumption. I borrow to invest. Hence, every dollar of the $700,000 of debt is working to make me more money. Also, the interest cost is tax deductible and I can use it to lower my income tax.

  2. You kind of allude to it but of course in tandem with debt management and reduction needs to be proper structuring of your budget. This MUST go hand in hand, otherwise, you risk repeating the cycle of getting back into debt.

    Steps to achieve this is twofold…
    – track your expenses…all of them
    – create a trackable budget…the most extreme controlled one is envelope budget…whole other topic but is part of getting out and staying out of debt.

    Good article…

    1. @Smayer97, using debt to invest requires a great deal of discipline, self-control and cash management. Otherwise, you’ll lose track of your debt and it ends up costing you money rather than helping you make money. If borrowing to invest is not for you, then staying out of debt is definitely a great idea.

  3. Being a debt is an awful feeling and something I try to avoid by staying within my means. That being said, my toddler needed medical attention over a year ago, and even with insurance, we are still paying down that debt. It has meant making a lot of sacrifices, and we’ve worked with the multiple hospitals involved to create a payment plan so it isn’t quite so daunting.

  4. This is great information. Having a lot of debt can be very overwhelming. These are great tips to help yourself get out of debt.

  5. When I first got a steady full time job I had a lot of credit card debt. I got a collateral loan from my mom. She put up her money and it went into a CD or money market account for two years while I was “paying it back”. She earned interest and I improved my credit while paying off all those cards.
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  6. These are all such great tips and perfect for people who need them. It really does help out when you’re in debt with student loans.

  7. Having debts is a norm these days. For whatever reason they use it for, it still falls under debt.So, I’ll go for the Two Cents.

  8. I will soon be in debt. We are buying an apartment and we all know what that means. Those are some great tips. I will start putting them in practice as soon as possible.

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